The UK's Deficit Dogma: The Lessons for the U.S.

In the U.S., the failure of the congressional super-committee to reach agreement on deficit reduction looks set to trigger massive automatic spending cuts in both domestic and defense programs from 2013 onwards. While debt reduction is unquestionably necessary in the medium to long-term, placing it ahead of building a strong economic recovery is likely to do more harm than good. The United States should look no further than the United Kingdom for proof of the folly of prioritizing fiscal austerity over laying the foundations for post-recession economic growth.

On taking office in mid 2010 Britain's Conservative-Liberal Democrat (note to American readers -- Liberal Democrat in the UK does not mean the same as in the U.S.!) Coalition government committed to eliminate the huge UK deficit in the course of one five-year parliament. Critics warned that such rapid retrenchment could only undermine recovery from the Great Recession of 2007-09 and make a double-dip recession very likely. Some critics pointed out that Coalition policy flagrantly contradicted Keynes's dictum about recession and post-recession fiscal policy, "Look after unemployment and the budget will look after itself." Most governments presently operate huge deficits mainly because their economies have shrunk, but the cyclical element of these deficits will decline automatically as recovery gains strength.

Deficit reduction does not in itself produce post-recession economic growth. Nor will it eliminate the deficit in a weak recovery. A government is able cut its spending whatever the economic circumstances but it cannot control its revenue. Without a strong recovery in place, retrenchment weakens growth so that government income falls. The United States had clearer proof of this particular pudding in the shape of the 1937-38 depression. FDR's party paid the price for his mistake in the 1938 midterms. Later presidents who ignored this lesson also paid the price at the ballot box -- whether in the defeat of their putative successor as happened to Richard Nixon in 1960 after Dwight Eisenhower insisted on balancing the budget immediately after the sharp recession of 1958, or failure to win re-election, as in Jimmy Carter's case in 1980. Determined to stick to his pledge to balance the budget by the end of his first term, Carter proposed an anti-inflation austerity budget in his final year in office. In doing so, he ignored the warnings of his chief domestic adviser, Stuart Eizenstat, about impending economic downturn: "We are proposing a budget program which is unachievable as well as undesirable in the present recessionary climate."

Britain's leaders would have done well to heed similar warnings about the folly of their fiscal course. They have amply demonstrated that efforts to balance the budget in a weak economy are self-defeating. When presented with proof that his balanced-budget projections were way off course, however, Chancellor of the Exchequer George Osborne came up with an extended version of the discredited Plan A rather than a new plan B.

On November 29, Osborne told Parliament that weaker growth and higher borrowing means that the UK faces an unprecedented six years of austerity. The ax will fall on public sector, which will lose 700,000 jobs, instead of 400,000 as previously projected (with additional austerity in the shape of a public-sector pay freeze for those who hold onto their posts), in order to cope with £111 billion in additional borrowing over the next five years. This begs the question of what will happen to the 700,000 who lose their jobs and the over two million who are currently unemployed. In Plan A, they were to be absorbed into an expanding private sector, but public retrenchment in combination with uncertainty over the euro crisis means that new private-sector jobs have not been created in anything like the number anticipated.

The Coalition has now put back the target for eliminating the deficit to 2017 (originally 2015), but the additional cuts needed to achieve this could well tip the economy into recession next year, which will put back the budget-balancing schedule even further. Osborne covered his embarrassment at missing his deficit target with the fig-leaf justification that Britain's dedication to austerity had found favor with the markets in the form of low interest for government bonds, which will make borrowing easier than it was for Eurozone countries, including Germany. Of course this rather ignores the reality that less borrowing would be needed if the economy grew more quickly with the benefit of a short-term fiscal boost. Once a sound recovery was in place, a program to eliminate the structural deficit would have good prospects of success.

To date the United States has taken a different and more effective route to Britain's in operating short-term deficits to boost the economy. The stimulus package of 2009 and the smaller program agreed at the end of 2010 have at least prevented the recession from being deeper than once looked likely. With Britain now facing a possible double-dip recession, the parallel economic data in the United States looks relatively rosy, with a 3 percent annual rate of GDP growth forecast in the final quarter of 2011. Meanwhile inflation is falling, thereby allowing the Federal Reserve more scope to operate on the unemployment side of its mandate.

However, the storm clouds of new recession may soon reappear if America resorts to premature retrenchment. The failure of the super-committee points to probbale renewal of political battles over the federal government's finances. This could mean failure to extend key stimulative measures agreed in late 2010, particularly the extension of unemployment benefits and the employment tax cut. If the American right is serious about cutting the deficit rather than merely pursuing an anti-government agenda, this can better be done if the current burst of growth can be sustained. Examination of developments across the Atlantic shows what happens when dogma trumps economic common sense in the pursuit of debt reduction.